Demand, More, to Whet

In Asia three central banks met
And all three explained that the threat
Of trade tensions rising
Required revising
Their pathway, demand, more, to whet

The RBNZ cut rates 50bps last night, surprising markets and analysts, all of whom were expecting a 25bp rate cut. The rationale was weakening global growth and increased uncertainty over the escalation of the trade fight between the US and China were sufficient cause to attempt to get ahead of the problem. They seem to be following NY Fed President Williams’ dictum that when rates are low, cutting rates aggressively is the best central bank policy. It should be no surprise that the NZD fell sharply on the news, and this morning it is lower by 1.4% and back to levels not seen since the beginning of 2016.

The Bank of Thailand cut rates 25bps last night, surprising markets and analysts, none of whom were expecting any rate cut at all. The rationale was … (see bold type above). The initial FX move was for a 0.9% decline in THB, although it has since recouped two-thirds of those losses and currently sits just 0.3% lower than yesterday’s close. THB has been the best performing currency in Asia this year as the Thai economy has done a remarkable job of skating past many of the trade related problems affecting other nations there. However, the central bank indicated it would respond as necessary going forward, implying more rate cuts could come if deemed appropriate.

The RBI cut rates 35bps last night, surprising markets and analysts, most of whom were expecting a 25bp rate cut. The rationale was… (see bold type above). The accompanying policy statement was clearly dovish and indicted that future rate cuts are on the table if the economic path does not improve. However, this morning INR is actually stronger by 0.3% as there was a whiff of ‘buy the rumor, sell the news’ attached to this move. The rupee had already weakened 3% this week, so clearly market anticipation, if not analysts’ views, was for an even more dovish outcome.

These are not the last interest rate moves we are going to see, and we are going to see them from a widening group of central banks. You can be sure, given last night’s activity, that the Philippine central bank is going to be cutting rates when they meet this evening and now the question is, will they cut only the 25bps analysts are currently expecting, or will they take their cues from last night’s activity and cut 50bps to get ahead of the curve? Last night the peso fell 0.4% and is down 2.5% in the past week. It feels to me like the market is pricing in a bigger cut than 25bps. We shall see.

This central bank activity seems contra to the fact that equity markets are stabilizing quickly from Monday’s sell-off. The idea that because the PBOC didn’t allow another sharp move lower last night in the renminbi is an indication that there is no prospect for further weakness in the currency is ridiculous. (After all, CNY did fall 0.4% overnight). The global rate cutting cycle is starting to pick up steam, and as more central banks respond, it will force the others to do the same. The market has now priced in a 100% probability of a 25bp Fed cut at the September meeting. Comments from Fed members Daly and Bullard were explicit that the increased trade tensions have thrown a spanner into their models and that some preemption may be warranted.

A quick survey of government bond yields shows that Treasuries are down 4bps to 1.66%, new lows for the move; Bunds are down 5.5bps to -0.59% and a new historic low; while JGB’s are down 3bps to -0.21%, below the BOJ’s target of -0.2% / +0.2% for the first time since they instituted their yield curve control process. Bond investors and stock investors seem to have very different views of the world right now, but there are more markets aligning with bonds than stocks.

For instance, gold prices are up another 1% overnight, to $1500/oz, their highest in six years and show no sign of slowing down. Oil prices are down just 0.2% overnight, but more than 8% in the past week, as demand indicators decline more than offsetting production declines.

And of course, economic data continues to demonstrate the ongoing economic malaise globally. Early this morning, June German IP fell 1.5%, much worse than expected and from a downwardly revised May number, indicating even further weakness. It is becoming abundantly clear that the Eurozone is heading into a recession and that the ECB is going to be forced into aggressive action next month. Not only do I expect a 20bp rate cut, down to -0.60%, but I expect that QE is going to be restarted right away and expanded to include a larger portion of corporate bonds. And don’t rule out equities!

So, for now we are seeing simultaneous risk-on (equity rally) and risk-off (bond, gold, yen rallies) on our screens. The equity investor belief in the benefits of lower interest rates is quite strong, although I believe we are reaching a point where lower rates are not the solution to the problem. The problem is economic uncertainty due to changes in international trade relations, it is not a lack of access to capital. But lowering rates is all the central banks can do.

Overall, the dollar is stronger this morning as only a handful of currencies, notably the yen as a haven and INR as described above, have managed to gain ground. I expect that this will continue to be the pattern unless the Fed does something truly surprising like a 50bp cut in September or even more unlikely, a surprise inter-meeting cut. They have done that before, but it doesn’t seem to be in Chairman Powell’s wheelhouse.

The only data today is Consumer Credit this afternoon (exp $16.0B) and we hear from Chicago Fed President Charles Evans, a known dove later today. But equity futures are pointing higher and for now, the idea that Monday’s sharp decline was an opportunity rather than a harbinger of the future remains front and center. However, despite the equity market, I have a feeling the dollar is likely to maintain its overnight gains and perhaps extend them as well.

Good luck
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Rate Hikes to Condone

Today’s UK data has shown
The pace of price rises has grown
Surprising most folks
And likely to coax
Mark Carney, rate hikes to condone

The British pound is outperforming today, currently up 0.35%, as the market responds to a higher than expected inflation reading released this morning. CPI printed at 2.7%, well above the 2.4% consensus view and perhaps signaling that UK inflation, after a summer reprieve, is set to return to its post-Brexit peak of 3.1%. This has traders increasing their estimates of rate activity by the BOE, starting to price in tighter policy despite the ongoing uncertainty created by Brexit. As such, it should not be too surprising that the pound is firmer.

But the pound is by no means alone in its performance characteristics this morning, with the dollar weaker against virtually all comers. In fact, only two of the G10 bloc has suffered today, CHF (-0.45%) and JPY (-0.1%), the two haven currencies. The implication is that risk-taking is back. Certainly equity markets have been holding up their end of that bargain, with US markets strong performance yesterday feeding into strength throughout most of APAC last night led by Shanghai’s 1.1% gains and the Nikkei’s 1.0% rally. European shares, however, have seen a less positive reaction, as they are up at the margin, but only a few basis points, with some markets, notably Italy, actually suffering. (Italy, however, is feeling the effects of the imminent budget deadline with no cogent plan in place and significant differences between the government’s election promises and the fiscal restraint imposed by the EU.) But the other haven asset of note, US Treasuries, has also sold off, with the 10-year yield now trading at 3.05%, its highest level since late May. All told, despite the ongoing trade tensions, it seems that market participants are increasingly comfortable adding to their risk profiles.

More proof of this concept comes from the huge leveraged debt financing completed yesterday by Blackstone Group, where they borrowed $13.5 billion to purchase 55% of a Thompson-Reuters data company called Refinitiv (who comes up with these names?) At any rate, despite ratings of B- by S&P and Caa2 by Moody’s, and a leverage ratio of between 7x and 8x of EBITDA, the deal was massively oversubscribed with yields printing at, for example, 8.25% for 8-year unsecured notes, down from an initial expectation of 9.00%. High leverage, covenant lite debt is all the rage again. What could possibly go wrong?

But I digress. Back in the currency world, the dollar’s weakness has manifested itself in the EMG bloc as well as G10. For example, despite a softer than expected inflation reading from South Africa, where the headline fell to 4.9% while core fell to 4.2%, the rand is firmer by 1.8% this morning. The story here is confusing as some pundits believe that the central bank may be forced to raise rates in order to help protect the rand, which despite today’s rally is still lower by 10% this year. We have seen this type of behavior from Russia, India and Indonesia, three nations where domestic concerns have been outweighed by their currency’s weakness. However, there is a large contingent that believe the SARB will stay on the sidelines as they seek to encourage growth ahead of the presidential elections scheduled for the middle of next year.

It is not just the rand, however, that is showing strength today, but a broad spectrum of EMG currencies. These include MXN (+0.35%), INR (+0.45%), TRY (+1.5%), RUB (+0.5%) and HUF (+0.25%); as wide a cross-section as we are likely to see. In other words, this has much more to do with broad trends than specific data or stories. And with that in mind, it is hard to fight the tape.

It has become increasingly clear that most markets have made peace with the idea that the trade situation is not going to improve in the short run. Next week the US will impose 10% tariffs on $200 billion of Chinese imports and the administration is already preparing its list for an additional $267 billion of goods to be taxed. No economist believes that this will enhance the pace of growth; rather the universal assumption is that global growth will slow amid this process. And yet investors and traders have simply decided to ignore this outcome, with a large contingent explicitly declaring that they believe these are simply negotiating tactics and that there will be no long-term impact. While I hope they are correct, I fear this is not the case, and that instead, we are going to see this process carry on for an extended period of time, driving up prices and inflation and forcing the Fed to tighten policy more than currently priced by markets. If I am correct, then the likelihood of a significant repricing of risk is quite large. But again, that is only if I am correct.

As to today’s session, we see our first real data of the week with Housing Starts (exp 1.23M) and Building Permits (1.31M) as well as the reading on the Current Account (-$103.5B). But with risk-on today’s theme, these data would have to be drastically weak, sub 1.0M, to have an impact. Instead, it appears that the dollar will remain under pressure today, and perhaps through the rest of the week into next as the market awaits the Fed rate hike next week, and more importantly the statement describing their future views. Until then, this seems to be the theme.

Good luck
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